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Fred's (FRED) Q4 Loss Narrower than Expected, Shares Up

Zacks Equity Research

Fred's, Inc. FRED posted narrower-than-expected losses in fourth-quarter fiscal 2016. However, sales lagged the Zacks Consensus Estimate. Nevertheless, the company has witnessed improvement in bottom line on the back of  sequential growth in Retail Pharmacy adjusted script comps, sequential progress in sales trends in Specialty Pharmacy business, Front Store margin expansion and strong holiday seasonal category sales. As a result, its share price rose13.86% after market closing on Apr 6.

In fact, we note that in the past six months, the company’s shares gained momentum, due to the positive impact of the initiatives initiated in 2016. Shares rallied 50.7% outperforming the Zacks categorized Retail-Discount & Variety industry which dipped 0.3% in the same time frame. Further, we believe there is room for further upside which is also evident from its VGM score of ‘A’ and long-term earnings growth rate of 8.00%.

Quarterly Results

The discount retailer posted adjusted quarterly loss of 11 cents per share which was narrower than the Zacks Consensus Loss Estimate of 19 cents. The figure, however, was in line with the year-ago loss of 11 cents. Improvement in gross margins was offset by lower comps.

Fred's, Inc. Price and Consensus

Fred's, Inc. Price and Consensus | Fred's, Inc. Quote

Revenues & Margins

Fourth-quarter sales slipped 4.5% year over year to $529.7 million and lagged the Zacks Consensus Estimate of $531 million by 0.24%.

Comparable store sales dipped 3.6%, narrower than a 3.8% decline recorded in the preceding quarter. However, results compared unfavorably with 1.7% gain reported a year ago.

Gross profits slumped 2.5% year over year to $129.6 million, while gross margins increased 50 basis points (bps) to 24.5%, driven by the successful and profitable sale of discontinued inventory. We note that this gross margin increase was significantly better than the 480 bps decline in gross margins in the preceding quarter, which was due to soft sales and continued reimbursement pressure in the pharmacy category.

In the fourth quarter, Fred’s incurred an operating loss of $22.2 million, compared to a loss of $5.1 million incurred a year ago. Losses increased due to higher selling, general and administrative expenses.

Selling, general and administrative expenses, including depreciation and amortization, expanded 380 bps to 28.7% of sales mainly due to higher professional, legal, banking and integration planning fees incurred in connection with the announced agreement to acquire Rite Aid stores.

The Rite Aid transaction

On Dec 20, discount retailer Fred’s entered into an agreement with Rite Aid Corp. RAD and Walgreens Boots Alliance, Inc. WBA to buy 865 stores located in the Eastern and Western U.S. and certain assets that are required for store operations. The deal is worth $950 million and was paid in cash.

Fred’s Pharmacy is working collaboratively with Walgreens Boots Alliance, Rite Aid and the Federal Trade Commission (FTC) to obtain the approval of Walgreen Boots Alliance’s pending acquisition of Rite Aid (announced in Oct 2015) and the divestiture of certain Rite Aid assets. Recently, Fred’s Pharmacy announced that it might buy additional assets, including up to 1,200 Rite Aid stores, in order to obtain the FTC’s approval of the transaction. However, the completion of the transaction is still subject to approval by the FTC and requires other customary regulatory approvals and closing conditions.

The acquisition of these stores will position Fred’s Pharmacy as the third-largest drugstore chain in the nation. It will also improve the company’s healthcare growth strategy and would largely benefit its customers, patients, payors, supplier partners, team members and shareholders.

Fiscal 2016 Results

In fiscal 2016, adjusted losses were 52 cents, narrower than the Zacks Consensus Loss Estimate of 59 cents. It was however wider than the year-ago loss of 20 cents per share.

Net sales in fiscal 2016 were in line with the Zacks Consensus Estimate but decreased 1.2% year-over-year to $2.13 billion, due to a 2.2% fall in comp sales.

March Sales

In the five-week period ended April 1, 2017, sales dipped 2.7% to $208.6 million, due to the decline of comps of 0.5% against an increase of 1.8% in Mar 2016. A delayed Easter (from March last year to April this year) and a shift in holiday sales into April more than offset the benefit of tax refunds (which were delayed from February to March).

Store Update

As of Jan 28, 2017, Fred’s operates 601 pharmacy and general merchandise stores and three specialty pharmacy-only locations, including 14 franchised Fred’s Pharmacy locations.

Looking Ahead

The company is witnessing consistently favorable sequential growth in Retail Pharmacy adjusted script comps along with sequential progress in sales trends in Specialty Pharmacy business. The company expects the sequential improvement to continue throughout 2017.

Fred’s currently carries a Zacks Rank #3 (Hold).

Key Pick from the Sector

Investors interested in the broader retail space may consider Burlington Stores Inc. BURL, which sports a Zacks Rank #1 (Strong Buy) and has long-term earnings growth of 15.85%. You can see the complete list of today’s Zacks #1 Rank stocks here.

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